Investors know how buying shares on the stock market benefits them (or how they hope it will). They expect to see the companies they invest in succeed, which will make them profitable through returns on their investment.
What some investors wonder about, though, is how selling stock shares benefits the companies who offer them. What advantages do corporations realize from the public sale of their stocks? What’s in it for them?
How Do Companies Benefit from Stock? What Happens Before They Go Public
The vast majority of American companies — nearly all of them, to be honest — remain privately owned. This means that they rely on their own resources to fund operations. These include businesses from the small-town diner and regional supermarket chains to relatively big accountancy firms. Some private businesses, like Cargill and Koch Industries, could do perfectly well as publicly-owned companies, but would rather remain private.
In private companies, owners draw from their financial reserves and revenue to keep going. They can also find private outside investors, usually family members or friends, to raise capital. Some private companies rely on extremely wealthy individuals (angel investors) or venture capitalist firms to invest in their business, while some newer companies have taken advantage of crowdsourced funding on the internet. Bank loans are also major sources of capital for private businesses.
Most privately-owned companies leave it at that. But some that are more ambitious and want to expand their operations get to a point at which offering public shares becomes a real opportunity, if not a necessity.
How Do Companies Benefit from Stock? What Happens When They Go Public
Once a company decides to go public, they go through a very deliberate process to get listed on the stock exchange. It usually takes a few months. Accountants analyze the company’s books to the smallest detail. Company executives usually go on the road to pitch their brands to primary market investors, the group that gets the first crack at shares when they’re finally made available.
After the company is approved by the Securities and Exchange Commission (SEC) to go public, they prepare for and announce the date of the initial public offering (IPO). They sell shares to a few investment banks, who will in turn sell those shares to the first batch of investors and eventually to the public at large. At some point in this process, they decide what price they will offer the first shares for.
When the IPO finally happens, some private investors bank on the hopes that they’ll earn a tidy sum by selling their shares to institutional investors who are looking to get in on the ground floor of a public company. Oftentimes, they’re right, but it’s never guaranteed. During this process, the price of shares can go up or down, depending on the excitement generated by high-worth investors.
Finally, the stock shares are released, the company’s ticker appears on the stock exchanges, and the public is officially invited to buy shares of ownership in the company.
Technically — or as far as the ledger is concerned — a company that you invest in does not receive the money you pay for shares. They’ve already gotten a lump sum from the financial institution or brokerage who paid for millions of shares, which they’ll then sell back to the public. So it’s the bank or broker who gets your money directly.
But in essence, the company has already gotten your money before they knew that the stock would be yours. It’s a bit of a whirlwind.
How Do Companies Benefit From Stocks? When the Money Rolls In
The most obvious benefit of going public — if everything goes right — is a sudden, large influx of capital for the burgeoning company to work with. There are a few reasons why this is important.
Business Expenses
With all of the income from shareholders, public companies have more resources to pay common operating expenses. This includes budget items like worker salaries, office leases, supplies, equipment, and everything else that any office or company needs to be able to run efficiently.
Research, Development, and Expansion
Anticipated growth is usually the biggest driver when it comes to opting to become a public company. Income that is generated from stock sales goes a long way toward researching and developing new products and services. Stock sale income also puts the company in a better position to expand its operations to other parts of the country or the world. Moving isn’t cheap!
Loan-Free Capital
Businesses rely extensively on bank loans while they’re still private — and those loans have to be repaid at some point. But when they go public, the money they get from selling stock is theirs, with no institutional repayment necessary. Of course, the new capital may be used to pay off the company’s outstanding debts, too. But they won’t be taking out a new loan to do so.
Stock Value Increases
This is pretty simple. When more people buy shares in a company’s stock, the price of those shares increases. If it can maintain upward momentum over years, investors will pay more money to get in on the action. This means that the company will get more income for each share. In turn, that may spur the next big financial benefit…
Long-Time Investors Cash Out
Many of the people who invested in the company when it was still private — possibly including the original ownership group — release their shares to the public at the IPO.
Some hold on to their shares a little while longer to see the company grow.
If these investors held multiple shares in the company, they stand to reap a lot of profits if they sell their shares after the company has made it big. This famously happened with “Microsoft Millionaires,” when several early investors and employees who held options in Microsoft cashed in when the company became the dominant force in the tech business.
Additional Benefits
Besides all of the advantages that come along with getting a bunch of cash, companies that go public enjoy other benefits.
Visibility and PR
Going public means being in the public eye. A company that gets listed on the stock exchange almost immediately sees a big increase in its visibility — much more than it had as a private entity. This kind of awareness is important for drawing in more customers — or if the company primarily works with other businesses, new partnerships.
Employee Recruitment
Public companies attract top talent. Potential employees may perceive the company as being a secure, dependable source of income. That makes it easier for the company to recruit highly qualified workers.
Companies that have a high profile in the public eye — or at least in their market segment — tend to be viewed as desirable places of employment. New workers will compete to get hired, and the company increases its competitive leverage when that happens.
Stock Options
Many companies offer their employees stock options as a form of compensation. Stock options allow employees to buy into company stock when it reaches a certain price point. This can help a public company to balance its financial bottom line, since it can technically replace the practice of paying out a portion of its cash reserves for salaries.
Some Drawbacks
As with just about any major decision in life, there are some potential disadvantages to becoming a public company and selling shares to the public. Some of them are significant enough to make private companies stay private. For example, Charles Koch of Koch Industries — the largest private company in America — vowed his company would never go public in December 2020.
Some of the drawbacks companies cite as reasons to stay private include the following:
Loss of Independence
Some private business owners value their autonomy and control over their companies. When a company goes public, a huge portion of that control goes away because it’s now owned by stockholders. Executives still control the direction of the company, but their roles convert to steering the ship rather than owning it.
Financial Accountability
Public companies are very closely regulated by the SEC and other authorities. Their books must always be made available to shareholders — in fact, available to everybody. There are no secrets anymore, and the company must comply with several regulations they wouldn’t have to when privatized.
More Pressure to Succeed
New investors can be impatient. When a company has a successful IPO, it means that investors have high expectations for its success. That can put additional pressure on the company to produce short-term results. Some companies, to put it mildly, do not work as well under pressure as others might.
Gorilla Trades: Matching Great Investors with Great Companies
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